On 27 November 2001, the Inland Revenue published draft legislation on the proposed exemption for corporate disposals of substantial shareholdings. It also published a technical note to accompany the legislation. This article will consider how it is proposed that this relief will operate for most companies. It will not consider the special provisions that will apply to life insurance companies.
Article by Nick Lloyd, a director of Wentworth Accountancy Services Limited, published in the February 2002 issue of Tax Adviser. The consultation process
The government recognised there was a need to provide some form of relief to companies making disposals of significant holdings of shares in other companies – to ensure the competitiveness of the United Kingdom (UK) in attracting corporate investors, and to facilitate corporate restructuring in the global market. Without a change, it was felt that international headquarters would increasingly be situated outside the UK in other European Union (EU) countries which had already adopted an exemption from tax on the disposal of large corporate shareholdings. This document is the result of the earlier round of consultation at which time there were two alternative reliefs suggested to deal with corporate disposals of significant shareholdings. The first was an exemption from tax and the second was a deferral of tax provided that the gain was reinvested. Perhaps unsurprisingly, responses to the first draft were overwhelmingly in favour of an exemption rather than a deferral.
Subject to final consultation (the closing date for comments is 31 January 2002) and the Parliamentary process, it is proposed that the new legislation will apply to exempt gains made by companies on the disposal of significant shareholdings in other companies on or after 1 April 2002. For companies that may be in a position to take advantage of the new provisions, there is therefore a strong incentive to delay disposals until after 31 March 2002. Where vendors wish to lock into a good offer for their shares, they could consider cross-options as a means of deferring the disposal whilst ensuring the outcome.
In addition to exempting gains from tax, the new provisions also disallow relief for any losses arising on the disposal of shares on which, had there been a gain, would have been exempt. The exemption for gains is the headline part of the legislation, however in advance of 1 April, the main planning opportunity is in relation to the proposed abolition of loss relief. Where a relevant shareholding is standing at a loss, companies should consider whether there is a means of crystallising the loss in advance of 1 April. This may be through a physical sale or through a negligible value claim. In the case of a negligible value claim, the draft legislation contains provisions to prevent the usual backdating of such a claim and therefore any negligible value claim must physically be made before 1 April 2002. Another option in the future to obtain loss relief would be to ensure that the trading company test is failed such that the provisions cannot apply, although the taper relief position of the individual shareholders would need to be considered. Regard will need to be taken in all cases of the anti-avoidance provisions described below.
The exemption is extended to cover the disposal of assets related to shares where the main exemption conditions are met. The scope of this provision is actually quite narrow and covers options and securities giving rights related to shares.
The main requirements for the shareholding are:
- it must constitute at least 20 per cent of the ordinary share capital and carry the right to at least 20 per cent of the profits and also the assets available for distribution to equity holders. This is one aspect of the draft legislation that could well change before implementation: the commentary states that ‘the Government is continuing to consider this to see whether it is possible to formulate a practical test which will better identify structural holdings to which the relief should apply’;
- this substantial shareholding must have been held throughout a twelve month period beginning not more than two years before the date of the disposal; and
- the company must have been a ‘qualifying trading company’ or a "qualifying holding company" throughout the ‘qualifying period’ and also immediately following the disposal.
The definition of a qualifying trading company is similar to that for taper relief in that it must not be engaged to a material extent in non-trading activities. Certain financial and investment activities including leasing and holding assets are treated as non-trade activities. Banking, money lending and debt factoring are however treated as trading activities. Activities that are preparatory to the commencement of a trade are also treated as trading activities.
A qualifying holding company is a company whose activities together with those of its 51 per cent subsidiaries meet the test for trading described above. As for taper relief, holdings of more than 30per cent in joint venture trading companies are treated as trading activities rather than investments. A joint venture company is one in which at least 75 per cent of the ordinary share capital is owned by five or fewer companies.
The qualifying period begins at the start of the most recent twelve month period for which the substantial shareholding requirement is met and ends on the date of the disposal.
It is interesting to note that although the trading requirements must be met up to the date of sale, it is possible for the exemption to apply despite the size of the shareholding not actually being substantial at the date of sale. When advising clients on the exemption, the adviser will therefore need to ensure that he considers this point when presented with disposals from a holding of less than 20 per cent. It also provides scope to obtain the exemption on partial sales within the two-year window. The cut-off may provide a future planning opportunity to obtain at least some relief for shares standing at a loss by having an initial disposal and then retaining a holding of just under 20 per cent until outside the period during which the exemption provisions continue to apply.
The investing company
The main requirement for the investing company is that it must have been a ‘sole trading company’ or a member of a ‘trading group’ throughout the ‘qualifying period’ and also immediately after the disposal.
It is interesting to note the absence of the word ‘qualifying’ from the description above of the types of company to which the exemption is available. This means that the restriction on certain financial activities referred to above do not apply to the investing company. A sole trading company is a trading company that is not a member of a group. Once again, the definition of a trading company is a company whose activities do not to any substantial extent include activities other than trading activities. A trading group is a 51 per cent group of companies taken together which does not to a substantial extent include non-trading activities. Again holdings of more than 30 per cent in trading joint venture companies are treated as trading rather than investment activities.
Extension of relief (anti-avoidance)
The exemption and denial of losses is extended to cover situations where the main exemption conditions were previously met but are not at the time of the disposal.
The conditions are that:
- at the time of disposal a substantial shareholding is held;
- a chargeable gain or allowable loss would otherwise accrue and form part of the company's chargeable profits;
- the selling company is UK resident;
- there was a time in the two years before disposal when on a disposal of the shares by the selling company or some other group member the gain would have been exempt; and
- if the requirements relating to the company invested in are not met, at some time during the two years ending with the disposal the vendor controlled the company whose shares are being sold, or controlled it together with associates, or it was a group company.
The Revenue’s consultation paper says that the reason for this further exemption is to prevent the exploitation of the main exemption, and to also exempt a gain in circumstances such as the liquidation of a company. Once again, when looking at disposals which prima facie are not exempt, the adviser must be alert to these further provisions and always look back at the two year period prior to the disposal. This also applies where shares have been or are about to be sold at a loss. One can readily imagine the unfortunate situation of a client ‘phoning for some last minute advice about shares standing at a loss which fail the basic tests. You confidently explain that the loss will be allowable despite the new provisions. Later, you find out that these provisions actually result in that loss not being allowable, but that had you advised the client to wait another couple of months he would have been outside the provisions and got the benefit of the capital loss.
Following a share-for-share exchange or some other form of reorganisation, a company could exchange shares which qualify for exemption under the new provisions, for ones which do not. The reorganisation provisions would apply such that there is no disposal on the reorganisation. This means that a gain that would be exempt in the absence of the reorganisation provisions would effectively be carried forward and charged on disposal of the replacement shares. To ensure that this does not happen, the provisions of Taxation of Chargeable Gains Act 1992 (TCGA 1992), s. 116(10), TCGA 1992, s. 127, and TCGA 1992 s. 192(2)(a) are ignored where the gain which would otherwise arise would now be exempt. This provision does not however apply if the effect of disapplying the reorganisation provisions would be to cause the reduction or withdrawal of relief under the corporate venturing scheme.
Where there has previously been a share for share exchange or a demerger, when considering the substantial shareholding test and the nature of the company invested, the exchange is not treated as creating a new holding. Instead, the holding and the company invested in would be looked at for the periods before and after the exchange/merger and either used to qualify for relief.
No gain/no loss transfers
Where the company (A) obtained its shares by means of a no gain/no loss transfer from another company (B), it is treated as having additionally held those shares for the period that they were held by the company (B) and with the same rights as enjoyed by company (B).
Deemed disposals and reacquisitions, repurchase agreements and stock lending
If there is a deemed disposal and reacquisition of the shares or the interest in shares for corporation tax purposes, the shares are treated for the purposes of the exemption as acquired on the date of the deemed requisition.
Where there is a sale with a repurchase agreement within TCGA 1992, s. 263A(1) which disregards the disposal, for the purposes of the period for the new exemption, the disposal and repurchase is similarly ignored. Similar provisions apply to stock lending arrangements.
The draft legislation includes provisions to charge previously postponed gains to tax. The gains covered are those that have been postponed on the transfer of assets to a non-resident company under TCGA 1992, s. 140 or under the gift relief provisions of TCGA 1992, s. 165.
As with taper relief, this exemption is supposed to be a simplification of the tax system that will reduce compliance costs. However, like taper relief, the reality is that the legislation granting the exemption is complex and littered with potential traps for the unwary. Once again, it will be important to be aware of the detail of the legislation and not just the headline relief if this is not to become another area of significant risk for Professional Indemnity purposes.
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February 2002 by